"The EU Bonds Story Rumbles On by Edward Hugh
Wolfgan Munchau was complaining only last weekend about the extraordinary narrow-mindedness of Europe’s economic and political leadership in the face of the current financial and economic crisis, from Ireland in the West to Hungary in the East, and from Greece in the South to Sweden in the North. But more than narrow mindedness what we are faced with is innocence and inability to react, and frankly I am not sure which is worst. I say “innocence” because it is by now abundantly clear that they simply haven’t yet grasped the severity of the problems we face (in countries like Spain, or even Germany itself, let alone in the East), and I say inability to react, since they are always moving too little and too late. The initial response to the banking crisis last October was one example (where we saw a landshift-style volte face in the space of only one week) and the way we are now confronting the need to live up to the promises then made about guaranteeing the banking sector, and in particular the “systemic” banks, would be another.
The complete confusion which seems to reign over at the ECB about whether or not the Eurozone can operate some sort of US/Japanese style quantitative easing would be a third.
Today we are faced with another example of how our leaders are busily dangling their toes in a water where a more seasoned mariner would simply see the need to dive in and rescue the drowning man.
It is reported this morning that Germany and France are now contemplating the possibility of bailing-out entire nations, rather than simply individual banks as European government budgets mount up and there sovereign debt ratings start to buckle under the weight of a growing and deepening European recession.
As reported in my post yesterday (here) German Finance Minister Peer Steinbrueck became the first senior European politician to broach the topic earlier this week, when he stated that some of the 16 euro area nations are now “getting into difficulties” and may need help, citing Ireland as an example. French officials are also reportedly concerned about how the current “stand alone” sovereign debt situation is leading to widening spreads on Austrian, Irish, Greek and Spanish debt as the cost of insuring against default rises to records. This is not simply a case of seeing “fiscal irresponsibility” punished, it is a mechanism whereby the eurozone can be peeled apart, and where those states who enter a negative dynamic and see the cost of finsncing their debt (and thus their bank bailouts) rises so prohibitively that it virtually excludes the possibility of giving fiscal stimulus to their sinking economies in such a way that a self reinforcing process may be produced, a process which only leads in the direction of one conclusion: sovereign default.
It is not just one or two quarters of negative growth we are talking about here, we are talking of deep depressions, and ones during which deep structural damage can be inflicted on the economies of those states who are hardest hit.
“When push comes to shove Germany, France, the larger players will bail out those smaller peripheral players,” said Alex Allen, chief investment officer of Eddington Capital Management. “You can’t let one part of the system fail because it leads to failure of the whole system.”
European deficits have evidently surged enormously this year as governments are faced with the need to provide funding for the heavily strained banking system and provide some kind of stimulus to their rapidly contracting economies. EU member states have already committed more than 1.2 trillion euros in an attempt to save the banking systems from collapse, and it is evident now that a second and possibly larger wave of bailouts may now be imminent.
In particular many of us our now concerned that the eurozone bond market could potentially face a crisis similar to that unleashed by the collapse of Lehman Brothers in September. As ECB board member Lorenzo Bini Smaghi put it earlier this month there’s a “risk that the mistrust that there is today in financial markets” is “transformed into mistrust in states.”
“I would be very reluctant to say: ‘O.K., let Ireland or Greece default, the market will sort it out, punish them for their irresponsibility of the past,’” said Thomas Mayer, co-head of global economics at Deutsche Bank AG in London. “They tried it with Lehman and realized that was not a good idea.”
The Spreads Widen
The gap between the interest rates Greece, Austria and Spain must pay investors to borrow for 10 years and the rate charged Germany yesterday rose to the widest since before they adopted the euro. Credit-default swaps on Ireland rose to a record on Feb. 16, climbing to 378.4 points. Greek credit-default swaps, 270 points on Feb. 16, show a 4.5 percent chance that the country will default in the next 12 months, according to ING Bank NV.
Are Bailout’s Possible Under Maastricht?
The simple answer to the above question is most emphatically yes, under article 119 of the Treaty. As follows:
Where a Member State is in difficulties or is seriously threatened with difficulties as regards its balance of payments either as a result of an overall disequilibrium in its balance of payments, or as a result of the type of currency at its disposal, and where such difficulties are liable in particular to jeopardise the functioning of the common market or the progressive implementation of the common commercial policy, the Commission shall immediately investigate the position of the State in question and the action which, making use of all the means at its disposal, that State has taken or may take in accordance with the provisions of this Treaty.
Which in plain English basically means, through you go with your coach and horses. Indeed the priverbial coach and horses have already been driven through, last November, in the case of Hungary.
“The European Commission stands ready to provide a loan of €6.5 billion to Hungary,” the EU executive said in a statement on Wednesday (29 October), adding that “the concrete modalities will shortly be finalised in cooperation with the Hungarian authorities”. Under the plans, the Commission will borrow money from the markets using EU-denominated bonds and then lend it to Hungary, without drawing from the EU budget. The facility is established under Article 119 of the Treaty.It is the first time that Brussels has used the instrument to help an EU country (see background). The facility foresees an overall ceiling of €12 billion of outstanding loans. This funding is limited to EU countries which are not part of the euro zone.
The €12 billion ceiling currently available for the bond facility has not so far been reached, but it has long been evident that other Eastern EU countries would need to draw from the facility for financial help. Thus it is hardly surprising to learn that French President Nicolas Sarkozy had already proposed raising the ceiling to €20 billion at an EU summit on 7 November.
“I will propose on 7 November that the European Union itself, which has 12 billion available to support a certain number of liquidities and to support a certain number of states, should go up to at least 20 billion (euros) to increase our capacity to respond to the crisis,” Sarkozy said, according to Reuters.
As one EU official told journalists at the time “the Commission could also change the regulation and lift the ceiling”. Or, in other words, when needs must, it will.
A Little History
The principle of borrowing money from financial markets on behalf of the European Community has previously been applied to grant aid to extra-EU countries, in particular before the 2004 enlargement. Kosovo, Moldova and Georgia are all currently receiving financial help through EU loans raised on the market. In January 1993, Italy, a member of the European Community (the EU’s forerunner), was granted an eight billion ECU loan to support its strained balance of payments. Since then, no member state has received financial help through this instrument.
The idea of borrowing money via the issue of EU bonds was first launched by former Commission President Jacques Delors via his 1993 plan for growth, competitiveness and employment. Delors initially wanted EU bonds to fund the European budget. But the majority of member states opposed the idea, fearing it would ultimately increase their expenditure on the Community budget.
Borrowed money has been used by the EU to fund projects in several cases, although the amounts involved have been small. For instance, a ‘New Community Instrumentexternal ‘ was used in the late 70s and early 80s to help regions affected by earthquakes in Italy and Greece. Italy has recently proposed using European bonds to fund key EU projects, but the idea garnered little support
The gateway for the coach and horses is also being prepared on another front, as the Financial Times reports this morning. In this case we are talking about the European Investment Bank, which, according to the FT, is set to lend the Europe’s car industry €7bn in the first half 2009 to support the manufacturing of environmentally clean vehicles. This is already a substantial increase on the approximately €2bn a year the bank extended to the sector before the crisis, and there may be more, much more, to come. Pathways are being prepared, even as the wheels on the carriage are oiled and the horses’ main groomed.
Philippe Maystadt, the bank’s president for the past decade, revealed the €7bn figure to the Financial Times, as he explained the EIB’s plans to shoulder a bigger financing burden in crisis-hit Europe. Member states have already asked the EIB to increase its annual lending programme by €15bn ($19.2bn, £13.3bn) to €63bn for this year and next in an effort to revive the economy.
So Why The Criticism?
So why, if there behind the scenes so many preparations are now being made did I start this pots by saying that more than narrow mindedness what I felt we were faced with is innocence and an inability to react? Well basically, because I think that Europe’s leaders are still in general denial on the scope of this problem. We are not talking simply of little cases, like Greece and Ireland, we are talking about potentially much harder chestnuts to crack, like Spain, and Italy, the Uk, and even Germany itself. Remember Germany’s economic is now contracting at an almost astonishing pace.
And the full extent of the problems in the German banking system as defaults mount in Spain and Eastern Europe is yet to be measured. Only today German Chancellor Angela Merkel’s Cabinet approved a draft bill allowing the state to seize control of property lender Hypo Real Estate Holding AG, paving the way for the first German bank nationalization since the 1930s. And the volume of assets thought to be likely to need to be bought by any bad bank (or banks) created ranges somewhere in the 300 to 600 billion euro range. So the fear here is not that a German sovereign default is looming, but that German debt may no longer maintain “benchmark” status, and thus the rate of interest the German government may have to pay to maintain its debt may rise, again impeding efforts to help maintain the economy afloat, and almost inevitably biting into the country’s already strained health and pension systems.
And one last example for today, of how the one half (the Commission) doesn’t know what the other half (the Nation State leaders) is up to. Joaquin Almunia (who is so often “really out to lunch” on economic issues, he is, as they say “challenged” by the complexity of macro economics) warned earlier this week that Brussels could take action soon against EU member states which let their budget deficits rise above the 3% threshold.
Me:The EU’s executive arm plans Wednesday to examine the budgetary circumstances of several countries, including France, Germany, Greece, Ireland, Malta, the Netherlands and Spain, to see whether action is needed. Most of them, notably France, Greece and Spain, have already forecast that their deficits will blow out beyond three percent of gross domestic product (GDP) — the limit set out in the EU’s Stability and Growth Pact.
France, which has called for the EU limit to be eased as governments grapple with the worst economic downturn in decades, has said it expects its deficit to be 3.2 percent GDP in 2008 and 4.4 percent in 2009. Ireland’s deficit is expected to blow out to 5.5 percent in 2008, and then 6.5 percent in 2009, with Dublin hoping to bring things back into line in 2011. Spanish authorities expect a deficit of 5.8 percent this year. Germany, Europe’s biggest economy, has forecast three percent this year but believes the figure could grow to more than four percent in 2010. Greece, for its part, foresees a deficit of 3.7 percent in 2009. The Netherlands is due to publish its latest figures Tuesday and might just scrape through."
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February 18th, 2009 at 8:33 pm
Via Paul Kedrosky:
http://www.ft.com/cms/s/0/8121d176-f8a6-11dd-aae8-000077b07658.html?nclick_check=1
German 10-year Bund auction fails for second successive time
By David Oakley
Published: February 12 2009 02:00 | Last updated: February 12 2009 02:00
A German sovereign bond auction failed yesterday amid growing danger signs for governments as they attempt to raise record amounts of debt to pay for fiscal stimulus packages and bank bail-outs, writes David Oakley .
It was the second successive failure this year of a 10-year Bund auction - usually one of the most sought-after - as demand fell 20 per cent short of the €6bn (£5.4bn)the German government wanted.
Gary Jenkins, head of fixed income at Evolution, said: “The failure of a German bond auction is a sign of the difficulties governments are going to face in raising debt at these historically low yields.”
The outcome signals trouble for governments as a record $3,000bn of debt is ex-pected to be raised this year in sovereign bonds - three times that of 2008.
German bond auction failures were rare until the credit crisis. Before the seven that failed last year, the last German bond auction not to reach its target was in July 2000, after the dotcom crash.
Carl Norrey, head of Eur-op-ean rates trading at JPMorgan said the restricted demand for this latest issue - sold at a yield of 3.28 per cent - highlighted the price sensitive nature of government bond markets as investors have ever more debt to choose from. “Price is all important in a market with an enormous supply.”
With spreads between German yields and those of other eurozone countries close to record wides, investors bought other eurozone paper this week be-cause of the extra premiums they could obtain for this debt.
Greece, the lowest-rated eurozone country that suffered a downgrade last month, comfortably sold €7bn on Monday, although it had to pay much higher yields than existing debt to sell the notes.
The Netherlands was also forced to pay higher yields than existing debt to sell 10-year bonds on Tuesday.”
Now Evans-Pritchard:
“Ultimately, the European Central Bank could purchase bonds from vulnerable countries in the open market. That would amount to a full monetary bail-out, and the de facto creation of an EU debt union.
Such proposals have been anathema to Germany in the past. ”
Doesn’t the buying of Greek bonds mean that some investors are betting that the ECB will back these bonds?